Square Manufacturing is considering investing in a robotics manufacturing line.

Question

Square Manufacturing is considering investing in a robotics manufacturing line. Installation of the line will cost an estimated $10.4 million. This amount must be paid immediately even though construction will take three years to complete (years 0, 1, and 2). Year 3 will be spent testing the production line and, hence, it will not yield any positive cash flows. If the operation is very successful, the company can expect after-tax cash savings of $7.4 million per year in each of years 4 through 7. After reviewing the use of these systems with the management of other companies, Square’s controller has concluded that the operation will most probably result in annual savings of $5.6 million per year for each of years 4 through 7. However, it is entirely possible that the savings could be as low as $3.2 million per year for each of years 4 through 7. The company uses a 20 percent discount rate. Use Exhibit A.8.

  

Compute the NPV under the three scenarios. (Round PV factor to 3 decimal places. Enter your answers in thousands of dollars. Negative amounts should be indicated by a minus sign.)

Best Case Expected Worst Case Net present value

Explanation / Answer

Answer

Net Present Value is = Present Value of Cash Inflow - Present Value of Cash Outflow

Since Cash Out Flow is year 0 so it will be same as PV @ 20 % of year 0 is 1.

Also Since Cash Inflows are started coming from year 4 so we will take the Commulative present value from year 4 to 7 @ 20 % which comes out as 1.498.

And accordingly :

Best Case Expected Worst Case A.Expected Cash Flows ( in $ thousand) 7400 5600 3200 B.Commulative Present Value Factor From 4 to Year 7 @ 20 % 1.498 1.498 1.498 C. Present Value Of Cash Inflows A*B 11085.2 8388.8 4793.60 D Present value Of Cash Outflow 10400 10400 10400 E Net Present Value (C-D) 685.20 -2011.20 -5606.40

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